The Apex Surety Company wrote a general fidelity bond covering defalcations by the employees of Watson, Inc. Th&eafter, Grand, an employee of Watson, embezzled $ 18,900 of company funds. When his activities were discovered, Apex paid Watson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Watson's auditors, Kane & Dobbs, CPAs. Which of the following would be Kane & Dobbs' best defense?

1. Apex is not in privity of contract.

2. The shortages were the result of clever forgeries and collusive fraud which would not be detected in an examination made in accordance with generally accepted auditing standards.

3. Kane & Dobbs were not guilty either of gross negligence or fraUd.

4. Kane & Dobbs were not aware of the Apex-Watson surety relationship.